New venture capital fund aims to fill a gap

Most of Canada’s big banks are investing in the Canadian Business Growth Fund for SMEs. REUTERS/Chris Helgren

A $1-BILLION EQUITY FUND aimed at filling a gap in Canada’s venture capital market could help fuel the M&A pipeline as more small and medium-sized enterprises (SMEs) get off the ground and become attractive targets for acquirers.

This past spring, Canada’s leading banks and insurance companies announced the creation of the Canadian Business Growth Fund (CBGF), which will invest up to $1 billion in equity in Canadian SMEs over the next decade. Typical investments will be in the $3-million to $20-million range. Just as importantly, the Fund will facilitate mentorship and access to talent pools to help these businesses achieve their full potential.

“There is a gap in the funding life cycle in our country between the venture capital stage and the IPO stage,” says Michael Smith, a lawyer licensed in Canada and New York who works out of Dickinson Wright LLP’s Toronto and Washington offices. “What’s missing is what a lot of people call growth capital — a gap that’s also called ‘the Valley of Death’ — and that’s what the CBGF is aimed at.”

According to Innovation, Science and Economic Development Canada, the SME sector employs 90.3 per cent of the country’s workforce, or some 10.5 million people.

“These are the companies that could really take off if they get the right kind of capital,” Smith says.

The growth capital gap is endemic to all the G20 economies, largely because large financial institutions have traditionally avoided the space. “The big banks’ commercial model doesn’t motivate them to get in on their own,” Smith says. “By coming together in this way, however, they’re spreading the risk very evenly.”

Many countries have tried to address the gap by establishing institutions similar to the Business Development Bank of Canada (BDC). But BDC, like its counterparts elsewhere, provides debt financing and takes security. Yet many SMEs are not in a position to fund growth by borrowing. Almost by definition, they’re maxed out and are therefore unable to benefit from many programs dedicated to lending to them.

Private equity has been unable to help because it’s prohibitively expensive to do the smaller deals that CBGF is targeting. Private equity also tends to seek a controlling position in return for its investment.

“Many SMEs don’t want to give up control at that relatively early stage, and the beauty of the CBGF is that the investing institutions will not be seeking it, instead looking for something in the neighbourhood of a 20- to 40-per-cent stake in return for their equity investment,” Smith says.

Unlike many attempts to stimulate SMEs, CBGF is not a government initiative. Victor Dodig, the president and CEO of the Canadian Imperial Bank of Commerce (CIBC), has been the primary champion of the Fund.

“These are the best brains on Bay Street putting money up on commercial terms,” Smith says. “The investments will not be 'gimmes,' but a novel private sector solution to the growth capital gap that will use the standard best practices of the private equity model.”

However that may be, it seems as if the CBGF backers, which in addition to CIBC include the Bank of Montreal, the Bank of Nova Scotia, the Royal Bank of Canada, the National Bank of Canada, Manulife Financial, Sun Life Financial, HSBC Bank Canada, the Laurentian Bank of Canada, Great-West Life Assurance Company and ATB Financial, are in it for the longer term.

“The idea is that the Fund will let businesses mature and ripen over a five- to 10-year period,” says Graham Topa of Aird & Berlis LLP in Toronto. “That’s far preferable to a quick exit if what you’re trying to do is have companies grow, develop and create jobs in the economy.”

Significant market demand and large institutions’ desire to exploit this niche in the capital markets augur well for CBGF’s success. Indeed, Smith believes the initiative could become a model for other G20 economies.

“The concept is novel and unique, and hasn’t been tried in any other G20 country,” he says.